Bloomberg News

McGraw-Hill Plummets After Australian Court Ruling

By David Fickling and Matt Robinson
November 05, 2012

The Australian dispute over S&P’s ratings was part of a suit accusing the company of misleading investors with its system for labeling a borrower’s creditworthiness. Photographer: Scott Eells/Bloomberg

S&P parent McGraw-Hill fell (MHP:US) as much as 7.1 percent in New
York, the most since August 2011, according to data compiled by
Bloomberg. It dropped 4 percent to $52.24. The parent of Moody’s
Investors Service declined as much as 4.4 percent, the most
since November 2011, before closing down 3 percent at $46.60.

S&P was “misleading and deceptive” in its rating of two
structured debt issues in 2006, Federal Court Justice Jayne Jagot said in her ruling released today in Sydney. The
Australian municipalities that brought the case are entitled to
damages from S&P and two other defendants, ABN Amro Bank NV and
Local Government Financial Services Pty., she ruled. The ratings
company said it will appeal.

“This is the first time that a ratings agency has been
held liable for their opinion in this way,” said Harald
Scheule, as associate professor of finance at the University of
Technology Sydney. It may spur efforts to move the industry
toward a model in which consumers instead of issuers pay for
credit opinions, he said.

‘Major Blow’

Twelve Australian councils claimed they lost more than 90
percent of the A$16 million ($16.6 million) they invested in so-
called Rembrandt notes rated AAA by S&P and linked to credit-
default swaps on investment-grade companies. The repackaging of
debt into securities with top rankings from S&P and other rating
firms contributed to more than $2 trillion in losses and
writedowns as Lehman Brothers Holdings Inc. collapsed in 2008
and the world fell into recession.

The 1,459-page ruling is a “major blow to the ratings
agencies, which for years have had the benefit of profiting from
the assignment of these ratings,” Amanda Banton, a partner at
law firm Piper Alderman, which represents the councils, said in
an e-mailed statement. It will promote transparency in the
ratings process, she said.

“We reject any suggestion our opinions were inappropriate
and we will appeal the Australian ruling, which relates to a
specific rating,” S&P said in a statement. The New York-based
unit of McGraw-Hill had argued that a report provided to the
Australian towns said investors can’t rely on the ratings
themselves as investment advice.

S&P reported $502 million in revenue in the third quarter,
the highest in 19 quarters as companies around the world tapped
debt markets at the fastest pace ever. McGraw-Hill is splitting
its ratings business from its education unit.

European Sales

The ruling may have implications in other jurisdictions,
said John Walker, executive director of IMF (Australia) Ltd. (IMF), a
company that invests in litigation and funded the action. IMF is
funding a claim in the Netherlands over 2 billion euro ($2.6
billion) in similar securities sold in Europe by ABN Amro and
rated by S&P, he said in an e-mailed statement.

The notes, known as a constant proportion debt obligation,
or CPDO, were arranged by ABN Amro, an affiliate of Royal Bank
of Scotland Group Plc, rated by S&P, and sold to the Australian
councils by municipal adviser Local Government Financial
Services.

The securities were unwound less than two years after the
towns bought them because credit spreads kept increasing and
their cash value was exhausted, according to a court filing.

Town officials said during the trial they hadn’t read all
of the accompanying documents and relied on the AAA rating to
make the decision to invest in the notes. Among the councils
that bought the notes was Corowa Shire, a three-hour drive from
Melbourne and home to the country’s biggest hog farm.

Upgrades Canceled

Cooma-Monaro Shire, a region in the Snowy Mountains south
of Canberra that lost A$1.9 million on the notes, had to cancel
planned upgrades to its footpaths and public toilets after the
event wiped out about half of its discretionary budget, mayor
Dean Lynch said by phone.

“That was a massive blow to our budget,” he said by
phone. “That money was essentially put aside for a rainy day.”

Local Government Financial Services purchased A$45 million
of the Rembrandt notes from ABN Amro and resold A$18.5 million
in 2006 and 2007, including A$17 million to the Australian towns
that sued, according to court documents.

A 13th township sued separately after losing more than 90
percent of its A$1 million investment in the securities.

‘Complex Judgment’

Local Government Financial Services also sued S&P, accusing
the company of breach of duty and negligence in giving the notes
the highest investment rating. It and the Australian councils
also sued ABN Amro, claiming it was negligent in passing on
S&P’s AAA ratings.

The municipal adviser is entitled to damages from S&P and
ABN Amro, Jagot ruled. The councils are entitled to damages
equivalent to their A$15.8 million in losses. A separate hearing
will be held to make final orders, she said.

“We are studying this long and complex judgment,” RBS
spokesman Allan Watt said in a statement.

ABN Amro was “knowingly concerned in S&P’s
contraventions” and engaged in misleading and deceptive
conduct, according to today’s ruling.